Argentina: Geared for growth

Author: | Published: 1 Jun 2011

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Argentina's economy has expanded at an average rate of 6.5%
each year since 2003. As a result, M&A and financing
activities are increasing and foreign investors are seeking to
continue doing business in Argentina despite intrinsic risks
and lack of structural reforms that are much needed and long
overdue.

In this growth scenario, investors have navigated different
routes for the purpose of funding their operations in Argentina
and overcoming different legal hurdles that sometimes make such
funding activities a challenge. Two of the most commonly used
channels have been debt and common equity. Preferred equity is
rarely used. There are some important corporate, tax and
foreign exchange control issues which need to be taken into
consideration when investing debt or equity in Argentina.

Debt

Local companies are generally not restricted from a legal
perspective from incurring debt. The incurrence of indebtedness
requires limited corporate action and board approval is
generally sufficient. In addition, it is common to find that a
blessing is sought from the shareholders, either as an extra
assurance to the creditor or as a way to rule out any personal
liability of the directors with respect to the
shareholders.

The main challenges when structuring a debt transaction in
Argentina will relate to how to structure the debt facility
such that it is feasible from an exchange-control regulations
perspective, and is also tax efficient.

The Argentinean Central Bank (BCRA) rules provide that
Argentine borrowers from foreign lenders must comply with the
Argentine exchange control regulations. Under these
regulations, Argentine borrowers must comply with the following
requirements: (i) a one-year mandatory reserve requirement
equivalent to 30% of the principal amount of the loan received,
which must be deposited in an interest-free, US-dollar
denominated, bank account in Argentina, which cannot be pledged
as collateral (the mandatory reserve); (ii) a minimum term of
one year to repay the principal of the loan; and (iii) the
conversion of the foreign currency into Argentine pesos in the
Argentine exchange market.

The mandatory reserve requirement is, however, excepted
if:

the loan has a duration of not less that two years,
taking principal and interest payments into account; and

the funds are used to invest in non-financial assets (for
example fixed assets, intangible assets per mine cost,
acquisition of exploitation rights, or intellectual property
rights).

Loans granted by multilateral and/or bilateral lending
agencies are also exempted from the mandatory reserve
requirement.

Debt: tax issues

Under Argentine income tax law, Argentine residents
(including branches and other permanent establishments of
non-residents) are taxed on their worldwide income. To
determine taxable income, Argentine taxpayers are allowed to
deduct their ordinary and necessary business expenses,
including – with some restrictions –
royalties, technical assistance fees and interest.

Thus, interest is a deductible expense for Argentine income
tax purposes, as long as the financing generating the expense
is used to derive taxable income. Likewise, expenses incurred
in obtaining, renewing and repaying loans are deductible. Loans
entered into with a foreign-related party must comply with
arm's length terms and conditions (see Transfer pricing
below).

When deriving taxed and exempt income, taxpayers must
apportion the interest expense on a pro-rata basis to deduct
the portion of interest corresponding to taxed income only.

Usual strategies to push down debt on acquisitions include a
leveraged buyout of the target company (LBO). Under this
structure, a local company purchases the shares in the local
target with third-party financing (usually, loans or
tax-preferred corporate bonds placed through a public
offering).

The Tax Authority scrutinised the interest deduction in an
LBO scenario, as well as in another where there was no merger
after the purchase of the shares. In both cases, the interest
deduction was disallowed because the Tax Authority construed
the income tax law to allow only the deduction of expenses that
are closely related to the generation of taxable income. In the
Tax Authority's view, the liability entry of the loan in the
acquiring company's financial statement is balanced with the
entry of the shares as an asset. Consequently, there is no such
close relationship to allow the interest deduction because
shares derive dividend income, which is not taxable.

However, it can be argued that such interest payments should
be deductible because:

dividends are already taxed at the distributing company's
level, following the integration system adopted by Argentina;
under this system, dividends that originate from earning of
local companies that have been taxed are not considered to
form part of the income net profits attributable to the
shareholders;

dividends are subject to equalisation tax when
distributed to shareholders. The Income Tax Law provides that
local companies must withhold 35% of the amount of dividends
and earnings that are paid in excess of the net taxable
income accumulated in the year before the distribution or
payment of those dividends or earnings; and

capital gains arising from the subsequent sale of
Argentinean shares by Argentine companies are subject to
income tax.

General Instruction 747

With this Instruction, the Tax Authority attempted to
challenge the deductibility of interest and exchange
gains/losses arising from loans in foreign currency between
companies located in Argentina and foreign companies for
reasons such as the lack of a formal agreement between the
parties, the failure to specify the terms for the repayment of
principal and/or interest and the failure to include an
interest rate in the loan agreement.

In addition, it is important to meet the aforementioned
formal requirements in the event of an LBO so as to avoid the
possibility that the Tax Authorities may challenge the exchange
gains/losses and interest derived from these loans.

Thin-capitalisation rules

Thin-capitalisation rules only apply to interest on loans
granted by foreign-related financial institutions to local
companies. Interest is not deductible when the debt/equity
ratio of the local company exceeds a 2:1 ratio. Interest that
is not deductible as a result of the application of this rule
should be re-characterised as a dividend and treated
accordingly.

Thin capitalisation rules do not apply to interest payments
subject to an effective 35% withholding tax – this is
the case for tax rate reductions under a double taxation treaty
– or to Argentine financial institutions and other
similar entities.

However, most double taxation treaties include a
non-discrimination clause under which thin capitalisation rules
do not apply to interest payments made to the treaty's other
party.

Transfer pricing

As per the provisions set forth below, interest payable by a
local company to a foreign-related company must conform to
normal market practices on an arm's length basis.

Transfer pricing rules apply to cross-border related party
transactions to determine their compliance with the arm's
length standard. For Argentine tax purposes, relationship is
determined by ownership; leverage, functional or other similar
influence; or residence in a tax haven. Cross-border licences
of trademarks and patents are also subject to transfer pricing
rules.

The most appropriate of five methods (which are similar to
the ones established by the OECD Transfer Pricing Guidelines)
must be used to prove that related-party prices are at arm's
length.

Payments from tax havens

Payments received by an Argentine taxpayer from a tax haven
are presumed to be undeclared income, which –
increased by 10% – is subject to income tax and value
added tax.

To avoid taxation, the taxpayer must produce supporting
evidence that those payments have been effectively originated
from activities carried out in such tax haven, or transactions
already informed to the Argentine tax authorities in previous
tax returns.

Because of this, funding a local entity with debt or equity
from a tax haven jurisdiction, even if the controlling parent
is not ultimately organised in a tax haven jurisdiction, is not
recommended.

Withholding tax on debt and methods to reduce or
eliminate

A withholding tax is imposed on payments of interest to
non-residents. The withholding rates for the payment of
interest to beneficiaries abroad are:

15.05% withholding tax (17.72% if grossed up) when it is
paid to foreign financial institutions supervised by a
Central Bank or equivalent agency, and residing in countries
not deemed tax havens or with exchange of information
mechanisms with Argentina with no resort to bank secrecy or
other types of privacy laws; and

35% withholding tax (53.85% if grossed up) for all other
cases.

These withholding tax rates could be reduced if a double
taxation treaty were to apply. The 12% withholding tax applies
to interest payments made to beneficial owners of such income
that reside in Belgium, Denmark, the Netherlands, Spain or the
United Kingdom, among others; interest paid to a German bank is
subject to a 10% withholding tax.

Elsewhere, interest payments will be subject to value added
tax (VAT) if the local company is a VAT taxpayer.

The applicable rate will be: (i) 10.5% if interest is paid
to a bank located in a non-tax haven jurisdiction; or (ii) 21%
in all other cases. The local company will be able to use the
VAT paid on the interest as a credit against its VAT
liabilities in the immediately succeeding month after such
payment.

The disbursement and repayment of the loan proceeds and its
interest will also be subject to tax on financial transactions.
This tax is imposed on deposits and withdrawals of funds to and
from bank accounts. The general tax rate is 6%. 34% of the tax
on financial transactions can be credited against the
taxpayer's income tax or assets tax liabilities.

In addition, loan agreements will be subject to stamp duty,
which applies on any written contract executed or with effects
in the Argentine provinces and the City of Buenos Aires. The
rate of stamp duty varies depending on the type of contract
executed and the jurisdiction where the local company is
located. In Buenos Aires the general rate is 0.8%.

Public offering of securities

Argentine corporations can issue corporate bonds (Notes) to
finance their activities. The issuance of notes and their
placement among investors are regulated by Law No 23,576, as
amended, and its

regulations thereunder.

Notes may be placed among retail or institutional investors
through a private or a public offering. notes will be subject
to the preferential tax treatment described in Section C below
if the

following two conditions are fulfilled:

a public offering and regulatory authorisation; and

a specified use of proceeds.

Proceeds of the placement of notes are used by the issuer
for: (i) working capital in Argentina; (ii) investments in
capital assets located in Argentina; (iii) debt refinancing or
restructuring; or (iv) capital contributions to a controlled or
affiliated corporation that will use the proceeds for any of
the aforementioned purposes.

The issuer must report the appropriate use of proceeds to
the Comisión Nacional de Valores within 10 business days
after their effective application.

If such application is to occur in stages, the
10-business-day term starts after the proceeds of each stage
are effectively used.

In this case, the issuer has to file a special report issued
by an independent public accountant, confirming that the funds
have been effectively used as planned.

Note issuers can avoid the mandatory reserve if the notes
are placed through a public offering authorised by the
Argentine Exchange Commission

Tax issues for investors

Interest on notes paid to non-resident investors is exempt
from Argentine withholding tax, provided that the
above-mentioned legal requirements are met.

If the notes issuer claims the exemption and fails to comply
with the legal pre-requisites, interest paid to non-resident
investors would be subject to the tax withholding described in
paragraph (f) above.

No Argentine tax is levied on non-residents that realise
gains from the sale of the notes or currency gains, regardless
of whether the legal requirements are met or not.

VAT

All services relating to the issuance, placement, transfer
or amortisation of Notes placed through a public offering, as
well as their interest payments and guarantees, are exempt from
VAT. On the other hand, the same services related to the
issuance of Notes offered through a private placement are
subject to VAT.

In the latter case, while most of the services will be
subject to VAT at the general 21% rate, interest payments may
be subject to the reduced 10.5% rate if they are made to
Argentine financial institutions or foreign financial
institutions resident in countries that apply the international
standards of banking supervision of the Basel Banking
Committee.

Personal asset tax

The personal assets tax is imposed on resident individuals'
assets located in Argentina and abroad, and non-resident
individuals' assets located in Argentina. For purposes of this
tax, notes are deemed taxable assets, whether they are
subscribed through a private placement or a public
offering.

However, no procedure for the collection of this tax has
been established in the law to the extent the notes are
directly held by foreign individuals.

The tax law also includes an irrebutable legal presumption
that securities issued by Argentine private issuers directly
held by foreign entities domiciled in a jurisdiction does not
require the registration of shares or private securities, and
either (i) pursuant to their bylaws or the applicable law, are
only authorised to engage in investment activities outside
their jurisdiction of incorporation, or (ii) are not authorised
to perform certain transactions authorised in their by-laws or
by the applicable law in their jurisdiction of incorporation,
are considered held by individuals domiciled in Argentina,
being therefore subject to this tax at a 2.5% rate payable to
the issuer.

However, Decree No 812/1996 establishes that the legal
presumption discussed above shall not apply to shares and
private debt securities, such as notes, whose public offering
has been authorised by the Argentine Exchange Commission and
are traded on Argentina or foreign stock exchanges.

Equity

As a result of the foreign exchange control restrictions to
providing debt to fund local operations, the most commonly used
mechanism to fund local investments has been equity, mainly
ordinary.

Funding a local company through equity is generally a very
simple matter to the extent the local company's shareholders
accompany the process.

The local company must pass directors' and shareholders'
resolutions accepting the contribution, increasing the stated
capital and issuing shares in consideration for the funds
received. Once the resolutions are passed, they are registered
with the local office of corporations along with an accounting
certificate that certifies that the funds have been effectively
provided in compliance with local rules and regulations.

If the local company has minority shareholders that will not
vote favourably to the equity issuance, then the main hurdle
will be the valuation of the company that receives the
funding.

Usually a third-party fairness opinion will be required to
support the valuation at which the equity is being issued such
that minority shareholders' interests are protected.

Preferred stock that have features of both equity and a debt
instruments are subject to certain key limitations under
Argentine corporate law, which have resulted in it being rarely
used.

Preferred dividends will be permitted to have a preference
on dividends and a preference in assets in the event of
liquidation.

However the main limitations will relate to the difficulty
in forcing the redemption of preferred equity and forcing
periodic distributions of dividends. Under Argentine law, a
holder of preferred shares cannot cause the local company to
redeem preferred equity that has a stated maturity, unless it
has sufficient retained earnings to do so.

Also, corporations may only distribute dividends out of
retained earnings. If there are no retained earnings, the
preferred dividends may not be distributed.

Capital contributions are not subject to the mandatory
reserve requirement as long as the capital contribution is
registered before the local public registry of commerce, which
is a simple administrative procedure, and the foreign investor
holds more than 10% of the capital of the local entity.

Usually the filing with the public registry of commerce is
submitted to the banking authorities and with that the
mandatory reserve is avoided. (A temporary deposit may be
initially required by the banking authorities and subsequently
released once the documentation is submitted.)

Capital contributions are not taxed in Argentina. As a
general rule, dividends distributed by Argentine companies are
not taxable in the hands of their shareholders, whether
Argentine residents or nonresident.

However, if dividends are distributed out of earnings that
were not subject to Argentine income tax (pursuant to the
general Argentine income tax regime), a 35% withholding tax
applies. Gains from the sale of shares of an Argentine
corporation by a non-resident stockholder are not subject to
income tax.

On the contrary, similar gains from the transfer by
non-residents of equity interest from other Argentine companies
may be subject to income tax.

Antitrust

If the capital contribution results in an economic
concentration transaction whereby any person attains control or
substantial influence, directly or indirectly, of the local
entity, the transaction may need to be cleared with the local
antitrust authorities.

However, certain economic concentration transactions are
exempted from the notification requirement, such as
subscriptions of shares of companies in which the acquirer
already owns more than 50% of the capital stock, or
acquisitions of bonds, debentures and non-voting shares or
notes of a company and subscriptions of shares of a single
Argentine company by a single foreign company which owns no
assets in Argentina or capital stock in other Argentine
companies.

About the author

Gustavo Garrido is co-founder of Estudio Garrido
Abogados, and its present managing partner. Previously
he was partner and member of the executive committee of
a traditional Buenos Aires law firm. He worked as a
foreign associate at the New York office of Sullivan
& Cromwell, and worked for several months at Studio
Chiomenti in Rome in 1993.

Garrido specialises in commercial law and particularly
in M&A, having obtained an LLM from Duke University
School of Law.

He is an invited professor of entrepreneurship at
Universidad de San Andrés and member of the
Evaluating Committee of the Naves Program at IAE
Business School and of Endeavor.

Garrido is also a successful entrepreneur, and
participates as a venture capital investor in companies
such as Otro Mundo (brewery), Biosima (biotech),
Centaurus (geothermal), Salix (forestry), Invertir On
Line (online trading) and Jardines de Roosevelt (real
estate).

He has been a member of the board of the local
companies of several private equity funds such as
Advent International Corporation, Eton Park and HM
Capital. Today he is a board member of the Toronto
Stock Exchange company Estrella Energy Services, of the
Buenos Aires Stock Exchange company Celulosa Argentina
and of other closely-held companies or Argentine
subsidiaries of foreign multinationals in the internet,
real estate, forestry, pharmaceutical and biodiesel
sectors.

Garrido is the president of the Geothermal Committee at
the Argentine Renewable Energy Chamber, and in such
capacity he is drafting the Argentine geothermal
law.

He has been recognised by the specialist media as an
M&A expert, and as such has been cited and
interviewed in many press articles.

Garrido is also a well-known art collector, with
particular focus on Argentine figurative art. Because
of his know-how in this field he was retained by the
government of Buenos Aires to draft the bill for the
Art District.

Raúl Granillo Ocampo is a partner of Estudio
Garrido-Abogados. His practice is primarily focused on
M&A, project finance, private equity and commercial
law.

He holds an LLM from the University of Virginia (2001).
From 2001 to 2003 he worked as a foreign attorney in
Arnold & Porter’s Washington, DC
office.

Ocampo has had an extensive career representing
national and international clients in
multi-jurisdictional transactions where risk allocation
and protection rights require legal, economic and
political expertise. He also advises clients on their
day-to-day regional operations in Latin America. He
acted as lead counsel to the sellers in the $200
million sale to Contax of 100% of the Allus group of
companies that provides contact centre and BPO services
and that has operations in Spain, Argentina, Colombia
and Peru.

He acted as lead counsel to Crystalis Grupo Seidor in
the acquisition of 51% of the equity stake of the
Crystal Solutions’ group of companies with
IT operations in Argentina, Chile, Bolivia and the
Caribbean, and as lead counsel of Patagonia Bioenergia
in the structuring, financing, construction and
subsequent refinancing of its 500 ton per year
biodiesel plant.

Ocampo represented Mandeville Argentina in its
acquisition of 70 small and medium-size Cable TV
companies, for an aggregate purchase price of
approximately $350 million, transforming it at the time
into the third-largest cable TV company in
Argentina.

Ocampo is also a writer of articles on his areas of
practice for the specialist press.